Recession: a period of declining real incomes and rising unemployment
Depression: a severe recession.
Economic fluctuations are irregular and unpredictable
“business cycle” , but they do not come in regular intervals. Expansion is
when business is going well and real GDP is rising
Most macroeconomic quantities fluctuate together
Real GDP is most common measure, but income, spending, and production all
fluctuate together. Recessions are economy wide and effect everything
As output falls, unemployment rises
When companies produce fewer goods, they lay people off
Short Run Economic Fluctuations
Classical dichotomy: changes in the money supply effect nominal not real
If the quantity of money were to double everything would cost twice as much,
but also have twice the income so it doesn’t matter (money veil)
• Long run but not short run!
Model of aggregate demand and aggregate supply: the model that most
economists use to explain short-run fluctuations in economic activity around its
Aggregate demand curve: a curve that shows the quantity of goods and
services that households, firms, the government, and customers abroad want
to buy at each price level.
Aggregate supply curve: a curve that shows the quantity of goods and
services that firms choose to produce and sell at each price level.
Aggregate demand curve
Y = C + I + G + NX
All contribute to aggregate demand, government spending is constant
Price level and consumption: the wealth effect
Adecrease in the price level raises the real value of money and makes
consumers wealthier, encouraging them to spend more. The increase in
consumer spending means larger quantity demanded.
Price level and investment: interest-rate effect
Alower price level reduces the interest rate (because people need to hold less
money and can put more in banks), encourages greater spending on
investment goods (because interest rates are lower and they borrow more) and
increase the quantity demanded.
Price level and net exports: the exchange-rate effect
Afall in the U.S price level causes U.S. interest rates to fall, the real value of
the dollar declines in foreign exchange markets. This depreciation stimulates
U.S. net exports and thereby increases the quantity of g&s demanded. Shifts in theAggregate demand curve
Change in how much people want to consume at any given price level
• Want to save more, or spend more (taxes make spend less)
Changes how much firms want to invest (buy new computer systems-rise)
• Investment tax credit- increase demand
• Money supply increase, lower interest rates, borrowing less expensive,
Buy more, shift right, vice versa